Cyprus Rescue: The Destruction of a Tax Haven

Cyprus is paying a high price for the $13 billion financial rescue it obtained from the E.U.: the destruction of a key pillar of its economy, its status as the offshore tax haven of choice for wealthy Russians

Cyprus is paying a high price for the $13 billion financial rescue it finally obtained from the E.U. early Monday after a week of high drama: the destruction of a key pillar of its economy, its status as the offshore tax haven of choice for wealthy Russians.

Under the terms of the deal, Cyprus will proceed with a massive cutback of its major banks. The biggest losers will be bondholders and depositors who have more than $130,000 in their accounts; the exact size of their losses still has to be calculated, but it could easily be above 20% and perhaps much higher in some cases. However, smaller depositors with less than $130,000 will be spared, a significant change from the initial rescue deal agreed upon a week ago that was rejected by the Cyprus parliament. Under that arrangement, all bank-account holders would have been taxed, regardless of the size of their deposits, to enable the island to come up with its own $7.5 billion contribution toward the bailout.

The deal still needs to be formally ratified by parliaments in E.U. countries, but — crucially — it has already jumped the biggest hurdle, that of approval in Cyprus itself. On Friday, the island’s parliament approved a range of legislation, including one to restructure the banking sector, which enabled the deal to be sealed.

The overall impact will be a dramatic change for Cyprus’ economy. Over the past 30 years, since the fall of the Berlin Wall, the island has banked on its ability to attract money from Russia and elsewhere as an offshore center. Oversight has been tightened up since Cyprus joined the E.U. in 2004, but it remains relatively lax by international standards, and foreign companies pay a flat tax rate of just 10%. For a while the strategy seemed to work well; Cyprus built up a gargantuan banking industry, which is currently about five times the size of its total economy, according to Standard & Poor’s.

About one-third of the $88 billion in deposits in those banks is from Russians, who have increasingly used the island’s banking system as a tax-sheltered conduit for their financial transactions worldwide. Indeed, Cyprus shows up in international statistics as a huge investor in Russia itself, as a result of “round-tripping” by Russians who didn’t entrust their money to their national banking system. According to European Central Bank statistics, more than 40% of the deposits in Cyprus banks are in excess of $650,000.

All of that is now in tatters. The Russian depositors will take the biggest losses in the bank restructuring, which will effectively shut down the second largest financial institution, Cyprus Popular Bank, better known as Laiki, and merge its “good” assets with those of its larger rival, Bank of Cyprus, which will be revamped. The two banks are in poor shape after suffering heavy losses on their loans to and investments in Greece.

To prevent a massive flight of foreign capital from Cyprus once the banks reopen this week, the government is putting in place some capital controls, which still have to be detailed. Already over the weekend, banks on the island limited ATM withdrawals to about $130 at a time. The imposition of capital controls has sparked some fears among economists of a bigger problem for the euro as a whole, since a single currency cannot function properly if capital cannot move freely. But the E.U.’s Eurogroup — the financial officials from the 17 nations that use the euro — stressed that these measures would be applied in a “temporary, proportionate and nondiscriminatory” fashion, and thus be permitted under existing law.

In the longer term, however, it’s hard to imagine why any Russians would continue to have faith in Cypriot banks. Russian President Vladimir Putin and Prime Minister Dmitri Medvedev both complained publicly last week about the way Russian investors were being treated in Cyprus, and the issue looks likely to become a painful thorn in relations between Russia and the E.U. But Russia itself didn’t heed the pleas for help issued by the Cyprus government last week; Finance Minister Michael Sarris returned from a trip to Moscow empty-handed.

The Cyprus government has agreed to take other significant measures to alter its tax-haven status, according to the Eurogroup statement announcing the deal. One is an independent evaluation of the island’s implementation of anti-money-laundering legislation. Another is an important overhaul of taxation: according to the statement, Cyprus has committed to increase withholding tax on capital income and its 10% corporate tax rate.

The ending of its tax-haven status will force Cyprus to revamp its entire economic strategy, and nobody’s pretending that will be easy. The island has a flourishing tourism industry and is also a shipping hub. But being a tax haven has provided livelihoods for thousands of people, including lawyers and trustees as well as bankers. “The near future will be very difficult for the country and its people,” acknowledged the E.U. Commission’s top economic official, Olli Rehn. “But [the measures] will be necessary for the Cypriot people to rebuild their economy on a new basis.”

In the aftermath of the crisis, once the passions have ebbed, no doubt someone will try to calculate in detail the costs and the benefits to Cyprus of having been an offshore financial haven. Right now, though, it looks like it was a big bust.

Peter Gumbel writes about European business and finance from Paris, where he has lived since 2002. He was worked as a staff writer for The Wall Street Journal, TIME and Fortune. The London-based Work Foundation named him "Journalist of the Year" in 2005.

Gumbel's latest book is France's Got Talent: the woeful consequences of French elitism. A digital version is available in English.

Russia will not sit by as their citizens wealth is stolen by Europeans. On top of that this will destroy the Cyprus economy and may bring back the horrible hostilities that have ravaged the country for decades. This is an instance where they should have pulled out of the EU and then defaulted.

@j.villain1 Nothing has been stolen by Europeans. They have put their money in banks that have failed. When that happens you lose money. Unlike, Ireland, Italy, Greece, Spain - the EU is not bailing out depositors this time because 1. they don't have to and 2. the majority of the depositors are not Europeans. Get over it.

Do your homework and put your money in a strong bank, don't go chasing high yielding banks as they are too good to be true. Pigs get slaughtered!

Go ahead and think that the Cyprus seizure means nothing. Contrariwise, the move tells the entire world that people can no longer safely store their wealth in banks. Of course, most people mind only when their own assets are seized. When that happens, the situation becomes much more unjust.

This ludicrous European Union policy can only be seen as an expropriation of Moscow's massive deposits in Cyprus, deposits that are actually KGB monies, used for espionage activities around the globe.

For those still not in the “know”, the “collapse” of the USSR was a strategic ruse under the “Long-Range Policy” (LRP), the “new” and more subtle strategy all Communist nations signed onto in 1960 to defeat the West with.The last major disinformation operation under the LRP was the fraudulent collapse of the USSR in 1991. The next major disinformation operation under the LRP will be the collapse of the Chinese Communist government by decade’s end. When this occurs, Taiwan will be stymied from not joining the mainland.”

Now you know why the hated Communist Red Star (political symbol of the USSR) is still placed on the bows of NEW Russian naval vessels and on the wings of Russian military aircraft.

You also know why the electorates of the 15 republics that made up the USSR continue to elect Soviet era Communist Party Quislings these past 21 years for their respective Presidents. Since the “collapse” of the USSR there have been 52 such presidential elections, with 42 being “elected” who were Soviet era Communist Party Quislings! That’s 76.92%!

If the “collapse” of the USSR were real, those Soviet era Quislings would have been either arrested in the interests of national security after the “collapse” or shunned by civil society in general. Remember, it was the Communist Party of the USSR (representing no more than 10% of the adult population) that for 74 years persecuted the other 90% of the Soviet population.

Imagine it’s 1784 America. The Treaty of Paris (1783) was signed the previous year ending the revolutionary war with Britain. So who do the electorates of the newly independent 13 colonies elect for their respective governors? They elect persons who were Loyalists (American supporters of Great Britain) during the war for independence! Of course, in reality the persecution was so bad for Loyalists in post independence America that they had to flee the country en masse for Canada.

Or try this one out: After the collapse of the South African Apartheid Regime in 1994, the majority black population reelect for their Presidents only persons who were National Party members before the 1994 elections!

Unfortunately it is not really true that this EU-Cyprus bank restructuring deal amounts to "the destruction of a tax haven." Far from it -- its "finance curse" is far from over, and it may also confront a "resource curse" on the horizon,

True, Cyprus' role as a "pirate banking" haven for cross-border deposits is over. Even Serbian kleptocrats and Russian mobsters who care more about money laundering than returns on assets will now view Cyprus as a risky place to stash liquid wealth or invest in real estate.

However, given the demonstrated incompetence of Cypriot AND EU bank regulators, few private clients will want to bother with this risk. This is especially true, considering that there are so many other first-rate banking havens left standing -- within the EU, UK, Luxembourg, and Latvia, as well as Andorra, Monaco, Switzerland and Singapore beyond it.

Indeed, all told, the net effect on haven banking is that "pirate bankers" from the world's other leading tax havens are probably having a very good week.

Furthermore, the EU's extraordinary sanctioning of capital controls for one of its member states -- effectively floating a separate version of the Euro without Cyprus having to float its own currency -- will also deter new money from entering Cyprus.

But while Cyprus' role as the European destination of choice for dodgy deposits is over, its several other haven roles are still firmly in place. It still offers, for example, a very low corporate tax rate, state-of-the-art trusts and shell companies, nd more than 1800 lawyers and 2500 accountants who are experts at manipulating them. These chicanery-prone arrangements don't depend on the banking system at all.

Nor does the crisis necessarily impact Cyprus' role as a "residential haven," offering relatively easy access to EU citizenship as well as nice beaches and a relatively safe place to stash one's family -- as several dozen FSU oligarchs can testify.

Finally, if the gas industry hype is to be believed, Cyprus may be on the brink of being able to exchange its "finance curse" for a "resources curse" -- as it begins to develop offshore gas reserves that are large enough to rank it in the world's top ten. Just large enough, perhaps, to reignite conflicts with Turkey, unless this situation is much more carefully managed than the EU seems likely to do.

Why anybody looks at Europe and wants to model any part of it into the USA is completely baffling to me. They are going to get into our pockets anyway via the upcoming UN assisted EU transaction tax. I'll never go over there again.

Why waste time with these mundane laws that punish, why not just load the fat-cats onto trains and send them to concentration camps? Then confiscate all the fat-cats wealth, squat in their former homes. Thats what the parasite class wants isn't it? I know I am being rather blunt here, but the middle class is stuck between the parasite class, and the politician elites, who come up with laws to confiscate hard earned retirement.

You know its funny one second the political elite complain that people are not saving enough, then when people do start saving, the political elite still isn't satisfied and confiscates the middle classes savings. This is noting less than white collar crime. "Oh, I have a political title that allows me, to confiscate others personal property." "I am a EU bureaucrat that gives me the moral right to steal your money right out of your account."

Europe, how long are you going to put up with those thieving devils in Brussels?

Its only fair that the rich fat cats pay their fair share. We should do this in US as well: 40% for balances (including 401k) if the balance is over $100K. And higher for the mega-rich - i.e. over $250K. Some people don't even have retirement accounts. It's time for some equality and fairness here. Bravo EU!

@nwo4uandme Why
limit it to 40% why not 100% and put them in work camps - those rich fat cats
need to pay for the crimes against the people .... The beauty to this is that
the rich fat cats can continue to work and pay for our stuff and we get to feel
good about ourselves and still not have to work hard... equality
and fairness at
work. I
am with you comrade

@HughWilson1@nwo4uandme That's a great idea! Take the money away from the wealthy and put the wealthy into labor camps. It's about time we do something to effect justice. AND.... suppose that Obama took 100% of all 401ks to pay off the national debt. That debt would be paid off only for seconds before politicians began a fresh new round of vote buying. Before long, the debt would again surpass $16 trillion... what would the Obama regime seize next? This cylce is going to do nothing but permanently impoverish everyone who is not part of the Power Elite Class.

@HughWilson1@nwo4uandme Exactly. If you took the wealth of the top 1% and re-distributed it, everyone could live a decent life without having to work like slaves. Return the means of production to the people and out of the hands of the 0.1%, that is the next step and needs to happen. But we really need to nationalize the banks first (mostly there - thank you Tim Geithner and Obama - heros!). Then we go after the other industries. People criticize Marx and Lenin. But if they did not have to spend all the resources warding off the constant threats and attacks of capitalist crime nations, the system would have worked just fine. Now that the good guys are finally in charge, both in the EU and the US, we can get to see it work.

@frankwall1965 Wow, Frank, are you really that stupid or are you just winding us up? As Maggie faously put it, socialism fails every time when it runs out of other people's money. Looks like Cyprus was tapped out, with many more to follow in a wake of once golden but now dead geese.